MILITARY RETIREMENT BRINGS BOTH TAXES AND TAX-FREE BENEFITS. HERE’S A QUICK BRIEFING!

On Veterans Day, we remember that many thousands of soldiers, sailors, Marines and Air Force and Coast Guard members are drawing pensions and disability payments following their service to our country.

Eric recently helped a veteran sort out the tax issues involved in that military-related pay. We thought we’d pass this guidance along to others who might be thinking ahead to their 2014 tax returns.  It’s a summary of benefits and taxability from the U.S. Army’s Web site.

Our client had retired from the regular Army. But this site also offers fact sheets for Army reservists and for Army National Guard members in active status, as well. You can find them at http://myarmybenefits.us.army.mil/Home/Benefit_Library/Federal_Benefits_Page/Federal_Taxes_on_Veterans_Disability_or_Military_Retirement_Pensions.html.

Like so many other Americans, we also thank any military veterans who might be reading this for their service and sacrifices!

Here’s the U.S. Army’s fact sheet about retirement and disability pay.

Federal Taxes on Veterans Disability or Military Retirement Pensions

Summary:

Military retirement pay based on age or length of service is considered taxable income for federal income taxes. However, military disability retirement pay and veterans benefits, including service-connected disability pension payments, may be partially or fully excluded from taxable income.

Eligibility:

Soldiers with service-connected disabilities may be eligible for Federal income tax exclusions of veterans’ benefits and disability pension payments.

Benefit Highlights:

Military Retirement Pay

Military retirement pay based on age or length of service is taxable and must be included as income for federal income taxes. The amount a retiree pays to participate in the Survivors Benefit Plan (SBP) is excluded from taxable income. For Social Security tax purposes, military retirement pay is not considered earned income and no Social Security payroll taxes (also known as Federal Insurance Contributions Act (FICA) taxes) are withheld from military retirement pay.

Military Disability Retirement Pay received as a pension, annuity or similar allowance for personal injury or sickness resulting from active service in the armed forces should not be included in taxable income if any of the following conditions apply:

1.    You were entitled to receive a disability payment before September 25, 1975;

2.    You were a member of the military (active or reserves) or were under a binding written commitment to become a member on September 24, 1975;

3.    You receive disability payments for a combat-related injury. This is a personal injury or sickness that:

  • Resulted directly from armed conflict,
  • Took place while you were engaged in extra-hazardous service,
  • Took place under conditions simulating, including training exercises such as maneuvers, or
  • Was caused by an instrumentality of war.

4.    You would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if you filed an application for it (the exclusion under this condition equals the amount you would be entitled to from the VA).

Veterans Benefits

Veterans benefits are also excluded from federal taxable income. The following amounts paid to veterans or their families are not taxable:

  • Education, training, and subsistence allowances.
  • Disability compensation and pension payments for disabilities paid either to veterans or their Families.
  • Grants for homes designed for wheelchair living.
  • Grants for motor vehicles for veterans who lose their sight or use of their limbs.
  • Veterans insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran’s endowment policy paid before death.
  • Interest on insurance dividends left on deposit with the VA.
  • Benefits under a dependent-care assistance program.
  • The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001.
  • Payments made under the compensated work therapy program.
  • Any bonus payment by a state or political subdivision because of service in a combat zone.

Retroactive VA disability determination

If you retire from the Army based on years of service and are later given a retroactive service-connected disability rating by the VA, your retirement pay is excluded from income up to the amount of the VA disability benefits you would have been entitled to receive. You can claim a refund on any taxes paid on the excludable amount by filling an amended return on Form 1040x for each previous year during the retroactive period (subject to statute of limitations).

You may exclude 100% of any severance benefit from your income if you receive a lump-sum disability severance payment and are later awarded VA disability benefits. However, any lump-sum readjustment or other non-disability severance payment you receive upon your release from active duty must be included in your income even if you are later given a retroactive disability rating by the VA.

The statute of limitations for claims of retroactive disability is generally within 3 years of when a tax return was filed. However, in cases where a retroactive service-connected disability rating determination is received, the statute of limitations is extended by a 1-year period from the date of determination for claims for credit or refund that are filed after June 17, 2008. This special statute does not apply to any tax year that began more than 5 years prior to the date of determination.

Additional Information:

For more information, please visit Internal Revenue Servuce Publication 525, “Taxable and Nontaxable Income,” Special Rules for Certain Employees/Military regarding fderal taxes on military retirement pay or veterans benefits maintained by the Internal Revenue Service. See http://www.irs.gov/publications/p525/index.html